A Look At The Intrinsic Value Of ESCO Technologies Inc. (NYSE:ESE)
Key Insights
ESCO Technologies' estimated fair value is US$97.54 based on 2 Stage Free Cash Flow to Equity
With US$103 share price, ESCO Technologies appears to be trading close to its estimated fair value
Analyst price target for ESE is US$121, which is 24% above our fair value estimate
Does the November share price for ESCO Technologies Inc. (NYSE:ESE) reflect what it's really worth? Today, we will estimate the stock's intrinsic value by projecting its future cash flows and then discounting them to today's value. The Discounted Cash Flow (DCF) model is the tool we will apply to do this. Don't get put off by the jargon, the math behind it is actually quite straightforward.
Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.
Check out our latest analysis for ESCO Technologies
The Method
We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.
Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:
10-year free cash flow (FCF) estimate
2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | |
Levered FCF ($, Millions) | US$102.5m | US$115.0m | US$124.3m | US$132.2m | US$138.9m | US$144.8m | US$150.0m | US$154.8m | US$159.3m | US$163.6m |
Growth Rate Estimate Source | Analyst x2 | Analyst x2 | Est @ 8.08% | Est @ 6.32% | Est @ 5.09% | Est @ 4.23% | Est @ 3.63% | Est @ 3.21% | Est @ 2.91% | Est @ 2.70% |
Present Value ($, Millions) Discounted @ 7.4% | US$95.4 | US$99.7 | US$100 | US$99.4 | US$97.2 | US$94.4 | US$91.1 | US$87.5 | US$83.9 | US$80.2 |
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$929m
The second stage is also known as Terminal Value, this is the business's cash flow after the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.2%. We discount the terminal cash flows to today's value at a cost of equity of 7.4%.
Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$164m× (1 + 2.2%) ÷ (7.4%– 2.2%) = US$3.2b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$3.2b÷ ( 1 + 7.4%)10= US$1.6b
The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$2.5b. The last step is to then divide the equity value by the number of shares outstanding. Compared to the current share price of US$103, the company appears around fair value at the time of writing. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.
Important Assumptions
We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at ESCO Technologies as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we've used 7.4%, which is based on a levered beta of 1.034. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.
SWOT Analysis for ESCO Technologies
Strength
Earnings growth over the past year exceeded its 5-year average.
Debt is not viewed as a risk.
Weakness
Earnings growth over the past year underperformed the Machinery industry.
Dividend is low compared to the top 25% of dividend payers in the Machinery market.
Expensive based on P/E ratio and estimated fair value.
Opportunity
Annual earnings are forecast to grow for the next 2 years.
Threat
Annual earnings are forecast to grow slower than the American market.
Next Steps:
Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. It's not possible to obtain a foolproof valuation with a DCF model. Rather it should be seen as a guide to "what assumptions need to be true for this stock to be under/overvalued?" For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For ESCO Technologies, there are three fundamental aspects you should further research:
Financial Health: Does ESE have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
Future Earnings: How does ESE's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!
PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks just search here.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
